Single-stock Trading Finds Fans In Futures Industry

Backers See New Source Of Business, But Some Fear That Smaller Retail Investors May Not Fully Understand Process.

After nearly two decades of contraband status, futures contracts on individual stocks are a little nearer to reality for U.S. investors--for better or worse.

The House last week heartily approved a futures industry deregulation bill that includes a provision allowing trading in futures on specific stocks, a practice that has been illegal since 1982.

And though chances are slim the measure can be debated and voted on in the Senate and hammered out with House leaders this legislative session, industry players are optimistic about its eventual passage.

"It's already been a miracle we got it this far," said Leo Melamed, chairman emeritus of the Chicago Mercantile Exchange, nodding to competing interests among regulators and exchanges involved in bringing the products to market.

In an era of intense competition for futures and options business from on-line and overseas markets, Chicago's futures leaders view single-stock futures as a potentially significant source of new business.

Futures contracts based on broad indexes of the stock market have always been popular, and lately smaller versions of those contracts have been the fastest-growing products at the Chicago Mercantile Exchange, noted Scott Gordon, the Merc's chairman.

"The growth has been astounding," Gordon said of the Merc's e-mini Standard & Poor's 500 and e-mini Nasdaq futures contracts.

The Merc wants to offer single-stock futures too. This would amount to an invasion of turf controlled by the Chicago Board Options Exchange, which trades options on about 1,650 individual stocks and also is working on plans to market futures contracts on single equities.

Meanwhile, the London derivatives exchange, which received approval for single-stock futures this year, has announced it will offer the products on five U.S. stocks beginning in January. At the moment, U.S. citizens would be precluded from trading those futures contracts, but a provision in the bill would lift that ban as well.

For the bulk of buy-and-hold investors, futures on individual stocks may not have much appeal. Indeed, when the American Association of Individual Investors polled its membership earlier this year, only a tiny fraction expressed interest in learning more about futures.

Still, for sophisticated investors, the contracts could offer an array of benefits, experts say.

Jack Bouroudijian, senior vice president for equity futures and options at Commerz Futures in Chicago, says investors could use the new tools to eliminate exposure to a single stock in an index. For example, an investor exposed to the S&P 500 stock index who had a negative view of some of the individual companies in the index could use single-stock futures to hedge against those stocks.

Investors also might use the contracts to express their ethical beliefs; for instance, someone with holdings in the S&P 500 who had strong anti-smoking feelings could use futures contracts on tobacco stocks to eliminate exposure to these so-called sin stocks.

Single-stock futures would add "a whole new dimension to trading," Bouroudijian said. "I'm very excited, and I'll be out selling this. It's the one leg of the triad that's been missing," he said, referring to stocks, options and now futures.

It's also a bit easier to "short" stocks with futures contracts, experts said. When investors want to bet that a stock will fall in value in the future, they can't always find a liquid market to sell a stock short through conventional means. But the futures contract could provide a way to do that.

"It's unambiguously good for investors," said Owen Lamont, associate professor of finance at the University of Chicago's business school. Among other benefits, he said, the futures would allow executives who have an overweighted portion of their portfolios in company stock to diversify risk without selling out their positions.

And while pricing varies dramatically, futures contracts in general can be cheaper to trade. By definition, an option investor pays a premium for the right, but not the obligation, to sell a stock at a certain price in the future. By contrast, a futures customer agrees to purchase a contract at an agreed upon price in the future.

Being locked into a future price is what some fear would wreak havoc on smaller retail investors--the point-and-click generation--who may not fully understand they can lose more than their initial investment on a forward agreement.

That's why CBOE Chairman William Brodsky expects the financial exchange community will move cautiously in promoting the contracts to retail investors.

"We take investor protection seriously," he said. "I don't think the exchanges will make this a big retail initiative."